Rightways

Thursday, February 6, 2014

Asian central banks fix the mess created by their governments

Tokyo: Asia's central bankers are being forced to juggle their day jobs with what their
governments have failed to do - steeling their economies for the hard
times.

Critics say many governments have done too little to remove barriers to
domestic and foreign business investment, cut red tape, upgrade
infrastructure and develop deep, well-functioning financial markets when
the region was flush with cheap money.

Now that economic rocks are emerging as the tide of the Fed's easy cash
recedes, central banks are having to step in, detouring from their price
and financial stability mandates, to shore up weak economies.

India and Indonesia were first in the firing line of investors last year
when the Fed's plans to scale back its $85 billion in monthly cash
injections started to take shape. Both took emergency steps, intervened
in markets and raised interest rates to shore up battered currencies.

Since then the Fed has started winding down its stimulus in earnest,
putting emerging markets on the back foot once again as investors look
to target the most vulnerable economies.

Indonesian and Indian authorities have improved their defences against
rapid outflows but their governments have failed to tackle supply
bottlenecks and market rigidities that fuel inflation and limit room for
policy manoeuvre, economists say. Both face national elections this
year that could lead to populist measures and further delay reforms.

In Thailand, months of political turmoil have paralysed government,
leaving the central bank as the mainstay of economic support.

"In India, and increasingly Thailand, the governments have not done
their part. There's a risk Indonesia goes this way as the elections draw
closer," said Subbaraman, who since mid-2013 has been warning of
emerging Asia's growing exposure to market turmoil.

Even in Japan and China, with their strong and stable political
leaderships, central banks appear to be doing most of heavy lifting.

In Japan, a blast of central bank money has boosted the economy and
markets, but Prime Minister Shinzo Abe's economic reforms have
disappointed.

China's central bank is trying to rein in an explosion of
off-balance sheet and risky lending as cautious government regulators
resist speedier financial reform that would force markets to price risk
more realistically.

Asian central bankers rarely air their frustrations in public. India's
former central bank governor Duvvuri Subbarao was an exception,
regularly sparring with New Delhi over economic reforms and rates.

Sometimes though, their concerns do bubble to the surface.

After a series of rate hikes by Indonesia's central bank, an official
there in October voiced his vexation that the government was not
tackling the root cause of a widening trade and current account gap -
its own spending.

"We need to address the cause of illness when running a fever," Dody
Budi Waluyo, executive director of Bank Indonesia economic and monetary
policy department told Reuters at the time. "The medicine should not
only be Panadol to lower the fever."

NEW RISKS

In picking up the reins from government, the risk is that central banks
will deliver neither the stability they seek, nor the economic support
that is needed.

In Japan, for example, the concern is that optimism spurred by the Bank
of Japan's massive cash injections will fade without reforms to
unshackle the economy's untapped growth potential and help overcome the
problems of a fast ageing society.

Indonesian and Indian central banks may be forced to tighten monetary
policy more than their slowing economies would otherwise have warranted
because of fragile market sentiment and sticky inflation that remains
high even when growth cools.

In an ominous sign for India, foreign
investors have been net sellers of the country's stocks this year.

Thailand's central bank is under pressure to fill the void left by
stalled infrastructure spending and provide the struggling economy with
stimulus, but is well aware of the risks.

"Maintaining monetary policy in an accommodative mode for a long period
of time runs the risk of delays in reforms as they may seem less
pressing and the risk of financial imbalances build up," Bank of
Thailand spokeswoman Roong Mallikamas said.

In Japan, one concern is that without fundamental reforms promised as
part of Abe's "Abenomics" revival plan, markets will reverse and Japan
lurch back into its deflationary equilibrium or "stagflation" - a spell
of tepid growth and rising prices. Japan Risk Forum, which groups risk
managers from Japan's major financial institutions, sees nearly a 50-50
chance of that happening.

"We cannot rely solely on monetary policy forever and the time will come
when the government's resolve will be tested by markets, likely around
summer," said Hiroshi Watanabe, head of state-run lender JBIC and
Japan's former top financial diplomat.

OWN MAKING

To be fair, central bankers may have contributed to their own
predicament by keeping monetary policies too loose for too long after
the global financial crisis, either because of political pressure or
fear of more turmoil.

Nomura estimates that taken as a whole, real interest rates measured as a
difference between official rates and inflation in Asia's 10 biggest
economies excluding Japan were negative for more than half the time
since 2008 - a recipe for rapid debt buildup and property and stock
market bubbles. By contrast rates were negative for only 16 percent of
the 1996-2007 period.

"By over accommodating the Fed's easing, central banks allowed asset
price inflation to occur, causing an intoxicating party in full swing,"
said Thirachai Phuvanatnaranubala, former Thai finance minister and
deputy central bank governor. "With tapering, the party is over. Some
emerging markets will now have to deal with the bubbles that crept up
while everybody dreamily enjoyed himself."

There are also some signs of change. India is embarking on an ambitious
monetary policy overhaul that would make it harder for the government to
lean on the central bank, while the government has curbed gold imports
and secured $34 billion in overseas financing to try to close its
current account deficit.

Indonesia's ban on ore exports drew fire, but it is a sign Jakarta at
least recognises the need to reduce its reliance on raw commodities
exports. It has also taken steps to shore up public finances.

Still, central bank efforts can easily unravel once elections are in
motion, said Toru Nishihama, senior emerging markets economist at
Dai-ichi Life Research Institute in Tokyo.

"As elections are looming in many emerging countries this year, no
matter how central banks tighten policy to control inflation, their
governments are tempted to loosen fiscal policy, offsetting central
banks' efforts," Nishihama said.